I’ve been doing lots of reading over the summer, and sharing what I’ve learned on Twitter. Alpha Trader by Brent Donnelly is one book that I thoroughly recommend. Brent is a forex trader and covers everything from trade management to psychology. One thing he pointed out is that there are only three reasons why any trader loses money. Either because you have no edge, you’re not following that edge, or variance.
There are, of course, reasons why traders lose money. Maybe they don’t have a strategy, or know what they’re doing, or maybe they want to feel pain to punish themselves, or don’t feel like they deserve to win.
But whatever exact reason it is, every single reason boils down into these three reasons. If you don’t have an edge – you’ll lose money. Solution? Find one.
Lack discipline and break your rules? Keep getting FOMO? Clearly, you’re not following your edge. Your edge in the market is the very thing that keeps you profitable long term. It’s no good having one if you don’t follow it.
The last one is variance. Trading requires luck – although luck is a short-term attribute which over time reverts to the mean. However, it’s possible to do everything right on a trade and still lose money. Several times. Over and over. It’s also possible to flip a coin 100 times and it land on heads each time. Is it likely? No. But it is possible. You can reduce the effects of variance by having an edge, following it, and managing your risk and keeping position sizes sensible. The reality is though is that nothing is guaranteed. Admittedly, I don’t know of a case where a trader did everything right time and time again and yet still ended up being a net loser and quitting. Luckily, two of the three of these reasons are under our control.
We can control lots of things in our trading. For example, our stock selection, our entries and exits, our position sizing and risk management, our management of the trade once we’re in the trade, our emotions and our mindset. With so many variables under our own control it reduces the effort of luck in trading. Every now and again you’re going to buy a stock the day before it announces a big profit warning. This is unlucky. But occasional multi-R losses are a part and parcel of this business – the key is to keep losses capped at 1R. Anything above 1 means you’re not sticking to your rules or you’re getting slipped. Both of which are something you can do something about.
One stock that has been on my watchlist for months – like Capita (CPI) – is Afentra (AET). Afentra is the old Sterling Energy which was a complete dog. However, with a new board, name change, and placing, the company is now a new vehicle compared to its former self.
The company has around £30m of cash on its balance sheet and a single asset in Somaliland fully carried by Genel Energy (GENL). With the share price at 14.75p, the company is worth £32.5m. This means that the company is trading at 90 per cent of its cash levels and so there is a small premium for management. The new chief executive is no stranger to the oil & gas industry in Africa, and so the market will be expecting him to use his connections to lever a great deal for the company.
Looking across to Chart 1 we can see how the business has consistently delivered poor returns for shareholders. Many may have been tempted when the stock broke through the 200 moving averages in the spring of 2016 but the price went sideways and went nowhere. This is why I believe it's often best to wait for a strong rally first and sit it out. If a stock is up 100 per cent from its lows (and stays there), then it’s clear that the bulls are in control and that there is enough demand to pick up loose stock at much higher levels than the lows. That didn’t happen here – and such an event would’ve tilted the odds of probability in the trader’s favour.
Moving across to Chart 2, we can see there has been a sustained rally in the company’s stock price. The trend is now firmly up, with all the moving averages pointing upwards and the stock around 100 per cent from its lows. With the price hovering around support, many investors will be looking at this area to try to pick up some stock. However, I’d rather get involved when I know the price is on the move. I’ve marked the 18p area as resistance and have an alarmed line – once the price gets close to that area I’ll look to try and enter.
Ideally, the stock will gently trend up to the resistance point. Seeing a stock rally sharply to resistance is often a good point to fade short as the stock exhausts itself and there is no new buying ready to take it through resistance. With volumes minimal at the moment the trade may take time but I can wait.
I like this potential trade because it’s well-financed, there is a clean sweep in the director reshuffle, and the trend is up. But as I said earlier: there are never any guarantees.
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